As a child growing up on a Midwestern dairy farm, I heard my father tell people, “Farmers are the only crowd that buy everything at retail, sell everything at wholesale, and pay shipping both ways”.

He would go on to further explain the disadvantage of producers in establishing a fair and equitable price that was profitable long-term; he would talk of other industries which could establish a price for their product, whereas we must accept whatever price the market determined to be fair. Perhaps you find yourself in agreement with these thoughts. In today’s environment of rising and ever-fluctuating input costs and remarkably sensitive milk prices, the argument seems to have more traction than it ever has. Or does it?

In 1995, milk futures and options were made available to the American dairyman. For the first time in decades, these producers were able to establish and/or protect the price of their production in the same capacity that they had been able to address their feed costs. Following the release of this new tool, co-ops also began to extend contracts to their patrons. In other words, producers now have the capacity to transition from being price takers to price makers. Why is this a big deal? Why should dairymen use these tools and become more involved in marketing and price risk management?

Market volatility
When studying the markets that impact dairymen, the most fluctuant market faced by the producer is milk. Figure 1* illustrates the movement of milk over the past 11 years. One simple truth that can be easily observed is that prices go up and prices go down. The extremes by which this is achieved is a function of the nature of the product in question. The more perishable a commodity is, the more volatile the corresponding market will be. Obviously, you cannot store raw milk for the same amount of time that you can store commodities like corn. If you give attention to the patterns of the past, the natural conclusion is that price has not stayed at the peak of any price rally for longer than five months. As of the time of this writing (January 2008), we are currently in the beginning of our seventh month of sustained high prices. Though I cannot give you an exact forecast for market movement, the market makes a very bold suggestion.

Revenue consistency
Because of the fluctuating prices, dairymen are subject to violent changes in revenue from one point in the calendar to another. Anyone that is considering or completing an expansion can appreciate the need to have some sort of control over this issue. Many lenders will not even consider an application without a written submission from the applicant that outlines their marketing efforts and resulting revenue streams. Contracting portions of monthly production at known prices provides an assured revenue stream while prices fluctuate.

Feed price
Figure 2* illustrates the relationship of milk prices over the past 10 years relative to feed cost (feed cost factor is a duplication of the feed component of the milk-to-feed ratio using an average hay price of $140 per ton over the period). What you will notice is that historical moves higher in milk price were not met with as extreme moves in feed price. That is no longer the case. Both the 2004 move as well as the recent move higher have been accompanied by dramatic increases in feed cost. As dairymen analyze milk marketing opportunities, it is also imperative to consider the contracting potential for feed inputs.

Peace of mind
Have you ever found yourself nervous, edgy or overly concerned about the viability and future of your business? Beyond the logical and mathematical justifications for becoming more involved in marketing and price risk management, your health is on the line. Establishing prices with your feed vendor or milk cooperative and using futures and options contracts allow you to manage your concerns about the future and to sleep better.

Where to start
There are several good reasons why dairymen should address the process of marketing and price risk management, but most dairymen struggle with the how. Where do you start? The answer is simple – with you! There is not a cookie-cutter, one-size-fits-all approach to managing price. Each operation is different. Each individual must assess their operation with regard to revenue needs, debt, feed source/supply, contracting capability with buyers and suppliers, as well as the market bias and personality of the decision maker.

It is also important to understand the historical relationship between the futures market and the local market that dairymen buy feed from and sell milk into. The similarities and differences of these markets are significant pieces of information in this consideration process. Once these considerations are made, a producer must put together a program that meets their needs and fits within their limitations.

In future issues of this magazine I will discuss five strategies by which a producer can manage price. These include: using fundamental indicators, applying seasonality, identifying cost-of-production plus margin, applying technical analysis and basing activity on historical price ranges. Producers must identify a strategy or combination of these strategies that they can apply as they make decisions concerning buying feed and selling milk.

Commodity brokerage firms can be of assistance with this. However, be selective when considering a firm. Be sure to use the expertise of a company that not only has access to the milk and grain markets, but also has a rich history with them. Choose a company that has a mindset of managing price, not making trades.

So what do I do right now? Currently, Class III milk futures are offering dairymen the opportunity to lock in averages of $17 for all of 2008. What will keep prices here? Outside market values like $100 crude oil, $4 corn and $300 soybean meal have had their influence on price levels. The current value of the U.S. dollar has spurred a strong export market for cheese, butter and other products. Recent rounds of holiday buying have maintained a strong domestic demand for dairy products. Though demand is firm, supply must not be overlooked. The nation’s cow herd is at levels not seen since 2000 with the productivity per cow continuing to set new records.

These statistics have historically been a sound indicator of general price direction. As cow numbers begin to increase, milk price has a strong tendency to turn lower only a short time later. As you can see, you can make a story to justify price movement in either direction. The important thing to remember is that your revenue is determined by only two things: production and price.

Today’s dairyman is a master at the science of production. It is price that has become the most vulnerable element of their management. You will either be in control of this element or subject to forces of the marketplace. Who do you want to hold your wallet? PD

References omitted but are available upon request at editor@progressivedairy.com

Figures omitted but are availabe upon request to editor@progressivedairy.com.